Bachelor of Accounting

ACC718 – Auditing and Assurance

Services

Topic 1: Audit Functions

Lecture Outline
• Introduction
• Define an audit
• Reasons for Auditing
• Audit expectation gap
Introduction
• Businesses, companies, organisations are owned by individuals or
group of individuals whom have entrusted other individuals
(managers) to manage their resources.
• However resources owners at some point have doubts in their mine
about the reliability of financial reports and the only way to prove
their doubts is by engaging an outside individual/s to review the
worked done by their managers. That outside individual is the
Auditor.
What is an audit?
• Audit is defined as, “it is an independent review and examination of
records and activities to assess the adequacy of system controls, to
ensure compliance with established policies and operational
procedures, and to recommend necessary changes in controls,
policies, or procedures.
According to ISA 200.
• The purpose of financial report audit is for the auditor to express an
opinion about whether the financial report is prepared in all material
respects in accordance with financial reporting framework.
What is Auditing?
• Is a systematic process of objectively obtaining and evaluating
evidence regarding assertions about economic actions and events to
ascertain the degree of correspondence between those assertions
and established criteria and communicating the results to interested
users.
Definition summary
• Audit sets out to achieve enhanced credibility of information
disclosed to increase reliability for the users of the financial
statements.
• Accounting is a representation of the economic situation of an entity
for a period which managers are required to represent to users.
• These representations by managers are known as assertions about
the economic actions and events of the entity.
• The auditor’s task is to obtain evidence to validate these assertions
and ensure economic events are appropriately communicated to
users.
Structure of an Audit
Management’s assertions to prepare a true and fair set of financial
statements.

The audit process to obtain evidence to validate the assertions.

Independent audit report to express an opinion as to whether the

financial statements are true and fair.

Financial statement users can use the information with reasonable

assurance that it is free of material misstatements.
Summary information
• It is clearly seen that the audit is an integral part of the financial
reporting process.
• Auditing is not adding any extra financial disclosure to users, but is
providing credibility to the disclosures made by management to users
of the financial statements.
• The question raise is to why organisations are prepared to pay to have
an external party come and audit their accounts to provide assurance
on the information disclosed. (discuss later)
What does an audit provide?
Auditor’s responsibility.
• to express an opinion on the financial report,
• the auditor’s report shall state that the audit was conducted in
accordance with Accounting Standard.
• an audit should be described. This includes stating that the auditor
has performed procedures to obtain evidence about the amounts and
disclosures in the financial report. The procedures will vary
dependent on the auditor’s assessment of the risks of material
misstatement,
• the auditor’s report shall state that the auditor believes that sufficient
and appropriate audit evidence has been obtained to form an
opinion.
What does an audit provide?
Auditor’s Opinion
• Whether the financial report presents fairly, in all material respects
(or represents a true and fair view), in accordance with the
applicable financial reporting framework.

The auditor is giving an opinion, not an absolute guarantee. The

assessments of presents fairly or a true or fair view are both based on
the condition that immaterial misstatements may not be detected.
Therefore the auditor is providing a reasonable level of assurance that
the financial reports are credible and can be relied on.
Why is there a demand for audits?
• Demand for audits apart from regulatory mandated has existed ever
since there has been separation of ownership and control of
organisations: Separation underlies the first reason for a demand for
auditing.
• Agency theory,
• Information hypothesis,
• Insurance hypothesis.
Agency theory.
• Separation of ownership and control of organisation. This theory
implies as….. “a contract under which one or more persons engage
another person to perform some service on their behalf which
involves delegating some decision making authority to the agent.”
• The owners entrust managers to run the company on their behalf, the
problem is that the managers do not necessarily have the same
incentives as the owners of the company, therefore owners have to
engage outside person (auditor) to review or audit the worked done
by the managers in order to have confidence in them.
• The role for an auditor to provide assurance on the reliability of the
financial statements produced by management was seen as valuable
to reduce the information doubt.
Obtaining a loan
• Before a bank permits you loan, it must first wants you to provide the
following information:
• Will the capital (loan) it provides you be secure?
• Will they continue to receive the interest on the capital from you?
• What happens if you stop paying?
• Whether you have security to secure your loan.
• Whether you have evidence of your existing assets.
• Providing such information will help them assess your request. These
pieces of information will give the bank trust, confidence, assurance
that you will repay your loan.
Information hypothesis.
• Audit improves the quality of information, which provides benefits
through,
• the reduction of risk,
• improvements of decisions, and
• the increase in profits.
• Investors will demand this information because it is useful for
decision making and will assist them in assessing the risks and returns
associated with their investments.
• The audit will reduce estimation risk (i.e. the uncertainty associated
with the realisation of future cash flows).
• There will also be value within the firm to assist in improving financial
data for internal decision making.
Information hypothesis.
• It can detect errors and motivate employees to exercise more care in
preparing records in anticipation of an audit.
• It is also a demand for auditing that also comes from a greater
number of users of financial information from both within and
outside of the firm.
Insurance hypothesis
• To assure investors and creditors and others who might demand an
audit to show that they are being prudent to insure against losses.
• Wallace put it like, “the ability to shift financial responsibility for
reported data to an auditor lowers the expected loss from litigation or
related settlements to managers, creditors, and other professionals
involved in the securities market. As potential litigation awards
increases, this insurance demand for an audit from managers and
professional participants in financial activities can be expected to
grow.”
• The regulators too benefit from the insurance aspect of auditing, who
can potentially insulate themselves from criticism and so have passed
certain regulations.
Insurance hypothesis
• The annual presentation of the financial reports to the shareholders
and carrying out of a statutory audit were made mandatory under the
Company Act.
• It regulated that all registered companies do require audits, on all
there accounts. This is due to the importance of reliability of financial
information in the markets and also is a broader public policy issue
for government.
Who provides audits?
• Financial statements audits are provided by external auditors, who
are either individual practitioners or members of public accounting
firms who render professional auditing services to clients
• Have the following virtue:
• Good education background,
• Training
• Experience
• Independent
• Work on a fee basis,
• Auditor must be independent of the client in carrying out an audit
and reporting the results.
What is assurance?
• An audit is an assurance engagement.
• Where information is prepared by one party (Accountant/Manager)
and then attested to its accuracy by another party (independent
auditor).
• Auditors provide reasonable assurance to the owner and public. That
reasonable level of assurance or the high level of assurance that
financial statement audit are free from material misstatement.
Audit Expectation Gap
• The difference between what financial statement users believe that
audit provides and what an audit actually does provide.

• Two gaps:
• A gaps between what society expects auditors to achieve and what they can
be reasonably expected to accomplish (reasonableness gap)
• A gap between what society can reasonably expect auditors to accomplish
and what they are perceived to achieve (performance gap).
Summary
• The audit function has successfully operated as a monitoring
mechanism to deal with agency problem for many years ago.
• The provision of assurance by auditors has been a way of adding to
the credibility and reliability or information, which adds value to the
information disclosed.
• Auditing standards are the guiding principles for auditors, and these
have developed significantly over the past thirty years,
• The success of auditing is also to do with how it is perceived by its key
stakeholders. Auditors owe due of care to shareholders, and others.